Fed Chairman Jay Powell has long argued that the US central bank could tame rampant inflation without plunging the world’s largest economy into a recession, claiming recently in July that he and his colleagues “are not trying to have a recession, and we don’t think we have to ”.
On Wednesday, however, that optimism faded as Powell made one of his darkest statements to date on the economic outlook in what has become the most aggressive campaign to tighten monetary policy since 1981.
“We need to raise inflation. I wish there was a painless way to do this, “he said at the press conference following the Fed’s decision to further extend its recent string of oversized rate hikes.” There isn’t.
Powell’s comments came as the U.S. central bank announced a third consecutive 0.75 percentage point hike to its benchmark rate, a move that took the federal funds rate to a new target range of 3. % to 3.25%.
Economists interpreted the message as an admission that Powell’s previously stated goal of achieving a “soft landing”, whereby the central bank can cool the economy without excessive job losses, was becoming increasingly unrealistic. The Fed chairman himself admitted that the odds of such an outcome “diminish” as longer tightening rates are sustained.
But what they also found surprising in Powell’s comments was the uncertainty he expressed about how severe a recession could result from the Fed’s efforts to eradicate inflation.
“The news from the press conference is the president’s acknowledgment that this is not just weak growth,” said Jonathan Pingle, US chief economist at UBS who previously worked at the Fed. “There is a very real risk of growth. recession and shows a very real willingness to face a hard landing. ”
Powell’s harsh valuation rocked the financial markets, with US equities canceling a previous rally to end the day down nearly 2%. The two-year Treasury bill yield, which is very sensitive to changes in monetary policy outlook, rose to a roughly 15-year high of 4.1%.
Powell’s message was reinforced by a revised series of economic projections released Wednesday by the Fed, which compiled officials’ individual forecasts for fed funds rate, growth, inflation and unemployment through the end of 2025.
Officials expect rates to rise to 4.4% by the end of the year before reaching a peak of 4.6% in 2023. In that period, the median estimate sees the unemployment rate rising to 4.4. % while growth slows to 0.2% this year and settles at 1.2% next year.
Core inflation, which excludes volatile elements such as energy and food, is expected to drop from 4.5% by the end of the year to 3.1% and 2.3% in 2023 and 2024 respectively. In 2025 it should remain just above the Fed’s 2% target.
The revisions – which still stopped before predicting a real economic contraction – marked a sea change compared to the previous estimates published in June. Those showed a much more favorable path for rate hikes, much lower unemployment and more robust growth even as inflation slowed.
“They wrote a forecast that actually quite implicitly has a recession,” said Vincent Reinhart, who worked at the Fed for more than 20 years and now works at Drefyus and Mellon.
He added that when the unemployment rate rises as significantly as politicians are now expecting, history suggests an economic downturn takes hold. Additionally, Reinhart said the unemployment rate may need to rise more than currently expected for the Fed to reach its price stability target.
“They admitted they had a lot of work to do, they admitted there would be pain associated with it, but they tried to minimize the pain,” he said of the new economic projections.
Many economists warn that a rise in the unemployment rate above 5% may be required to bring inflation back under control, with a group of academic economists recently suggesting that it may need to exceed 7%. Some also warn that the federal funds rate will eventually eclipse the Fed officials’ median forecast, reaching a peak of around 5% instead.
Much will depend on what happens to inflation, which has proved far more persistent and difficult to eradicate than expected.
Powell said the Fed will closely monitor incoming data to determine if it can slow its aggressive rate of 0.75 percentage point hikes. But according to BlackRock’s Gargi Chaudhuri, both inflation and the labor market are unlikely to drop sufficiently to warrant a smaller hike at the November meeting.
To stop the tightening cycle entirely, Powell said the central bank should be “confident” that inflation is falling, reiterating the hawkish message he delivered at the annual central bankers rally last month in Jackson Hole, USA. Wyoming, that the Fed will “keep going until the job is done.”
Peter Hooper, a nearly three-decade Fed veteran who is now the global head of economic research at Deutsche Bank, said the commitment will become increasingly difficult to meet as job losses begin to rise and the economic data will take a more decisive turn.
“The Fed is in a difficult position here politically,” he said. “We were told it will be painful, but the moment you start being specific about how much recession it will take, it starts generating a lot of opposition.”